March 28, 2016

Judicial Estoppel Not a Slam Dunk

by Guest Blogger

Seeing my Virginia Cavaliers lose to the Syracuse Orange and reading Mefford v. Norton Hospitals, reminds me that any discussion of judicial estoppel needs to be tempered by the doctrine's exceptions and that the game is not over after the first half. In Mefford, the Kentucky Court of Appeals reversed the trial court's summary judgment based on judicial estoppel. The debtor initially filed for Chapter 13 relief. Post-confirmation, Norton treated the debtor in its emergency room. The debtor moved to suspend her plan payments due to having "suffered several strokes and being unable to work." Shortly after suspending her plan payments, the debtor's malpractice counsel put Norton on notice of the potential claim and filed suit. The debtor continued to have difficulty making plan payments and the bankruptcy court ordered the dismissal of the case if the debtor failed to turnover her 2012 tax refund. Facing dismissal, the debtor moved to convert the case to one under Chapter 7. In her amended schedules and at the meeting of creditors, the debtor did not disclose the pending malpractice litigation. The debtor answered in the negative to a direct question regarding current lawsuits. After the bankruptcy court granted a discharge, Norton moved for summary judgment on the malpractice claim based on the debtor's failure to disclose the litigation in her bankruptcy schedules. The trial court granted the motion. The appellate court reversed and remanded.

The appellate court began with the proposition that judicial estoppel is a harsh remedy which "may bind a party to a position without regard to the 'truth-seeking function of the court.'" The equitable doctrine is not absolute with courts recognizing that it is not appropriate in cases amounting to nothing more than mistake or inadvertence. This inadvertence can be shown if the debtor lacks knowledge of the factual basis of the undisclosed claims or lacks a motive for concealment. Since the debtor had been deposed in the malpractice litigation and knew the factual basis, she instead relied on advice of counsel to show that she had no motive. At this point, the procedural history of her bankruptcy case became important. In a Chapter 13 bankruptcy, the bankruptcy estate includes all propertyâincluding tort claimsâ that is acquired during the pendency of the case. In a Chapter 7 bankruptcy, however, only claims which exist "as of the commencement of the case" become property of the estate. Prior to 1994, courts had split on the result in a converted Chapter 7 case. Congress amended § 348 to establish that, in the absence of bad faith, the estate property in a converted Chapter 7 only includes that which existed "as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion." Even with this amendment, post-conversion issues remain. Most recently, the U.S. Supreme Court has held that the Chapter 13 Trustee must return all undistributed payments upon conversion (Harris v. Viegelahn). But tort claims that arose post-petition have consistently been held not to be property of the converted estate. Courts have also pointed out that a Chapter 13 debtor does not have an obligation to disclose post-petition tort claims because they are not included in § 541(a)(5). Another issue pointed out in Mefford is that if the claim is completely exempt, there is no motive for concealment.

While Mefford came to the correct conclusion based on the procedural history of the bankruptcy case, it does raise a concern with the potential validity of an advice of counsel defense. After the debtor disclosed the pending litigation, her counsel made the professional decision not to list the litigation on the post-conversion amended schedules. While her counsel's assessment that the claim was not property of the estate was correct, Mefford should not stand for the proposition that, as long as it is the attorney that encourages the cynical gamesmanship upon which judicial estoppel is based, the debtor cannot be held responsible. In Mefford, this resulted in the debtor falsely answering a question of the Chapter 7 Trustee. He may have had no claim to the current malpractice litigation, but the debtor did have a current lawsuit. When the debtor testified falsely at the meeting of creditors, her counsel had some obligation to correct the testimony. Bankruptcy is a remedy for the "honest but unfortunate debtor" and the rule of disclosure by the debtor should remain one of full disclosure. Judicial estoppelâwhile a harsh remedyâprotects the integrity of the bankruptcy process by preventing the gamesmanship which was present in Mefford.